Making Catastrophic Health Care Affordable: A Nine Point Program

About the Authors

I February 10, 1987 MAKING CATASTROPHIC HEALTH CARE AFFORDA BLE
A NINE POINT PROGRAM INTRODUCTION Pressure is growing in Congress
for legislation to address the problem of catastrophic health care
costs, the high medical bills that can force Americans into
bankruptcy or onto welfare. There is wide agreement that a c tion
on this is needed to deal with the financial problems of three
groups: elderly Americans facing enormous hospital bills exceeding
their Medicare coverage, the elderly who need expensive long-term
nursing care, and working Americans with inadequate or no health
insurance. But while there is agreement on the need, intense debate
rages over the most effective approach.

In last year's State of the Union Address, Ronald Reagan
instructed Health and Human Services Secretary Otis Bowen to
'prepare a study on how the issue might be tackled. Bowen's report,
issued late last year, contained some valuable proposals for
encouraging the private sector to provide better coverage for
working Americans and for long-term care costs. But the main thrust
of Bowen's prop o sal significantly expanded the Medicare system by
many liberals who welcome it as a first step toward a
taxpayer-financed national health service. Bowen's scheme was
criticized by conservatives who fear that it would displace
existing private insurance fo r the elderly and open the door to
enormous deficits in the Medicare system, since lawmakers would
have the incentive to hold premiums down while voting for more and
more generous coverage This was embraced eagerly In his 1987
State.of the Union Address, R e agan reaffirmed his intention to
offer legislation soon to deal with catastrophic health costs. He
wisely stopped short of endorsing the Bowen plan I recognizing the
danger of an open-ended financial commitment by the federal
government. Yet Reagan did no t spell out his alternative to
Bowen.

This alternative is needed. Elderly Americans who believe that
the potential financial threat they face would be ended by Bowen's
Medicare plan are being misled. Between Medicare, Medicaid, and
private insurance, the v ast majority oe.America!s elderly>are
covered for catastrophic expenses for doctors and hospitals. The
few who remain exposed to catastrophic costs could be covered by
changing the law governing private Medicare supplemental (Medigap)
policies, to enable t hem to provide inexpensive catastrophic
protection rather than requiring them to provide high cost
first-dollar coverage for the copayments charged by Medicare. This
change would reduce dramatically the cost of private insurance for
the elderly. Indeed, t he cost of supplemental private insurance
giving coverage comparable to the Bowen plan would cost no more
than the Medicare premium increase envisioned by the Secretary, and
there would be no need to expand the federal role.

The catastrophic costs associat ed with long-term care are more
difficult to solve lead to staggering outlays, financed only by
huge increases in Medicare premiums or large hikes in the payroll
tax are ways to encourage employers and working Americans to set
aside funds, or to obtain in s urance, which would become available
when they retired. This insurance would protect them against the
enormous cost of several years in a nursing home. Long-term care
insurance would encourage Americans to plan for their future: by
contrast, using Medicar e to cover such costs would encourage
Americans to wait until it is too late and then force the next
generation to pay the bills catastrophic health costs for
underinsured working-age Americans can be solved largely without
increasing federal involvement. S teps such as requiring
tax-deductible group insurance to provide catastrophic coverage
would involve little, if any, increase in premiums yet would solve
most of the problem. And encouraging state risk pools, which spread
the insurance costs of such hard- t o-insure individuals as those
with existing medical problems, would address the difficulties. of
many Americans who are unable to obtain insurance should be
addressed not by transforming Medicare into a veiled form of
national health insurance point progr a m that would Paying for
long-term care through Medicare would Needed instead As with acute
hospital care costs for the elderly, the problem of The
catastrophic and long-term care needs of Americans thus Congress
should instead consider a nine 1 Change the law governing private
policies supplementing Medicare to require insurance companies
marketing policies to provide catastrophic hospital coverage 22
Provide vouchers through Medicare to assist the elderly to purchase
private catastrophic-insurance policie s 3) Make greater use of
Medicare vouchers, to encourage the elderly to obtain better health
care at lower cost 4) Encourage private long-term care insurance. l
5) Require tax-deductible company health plans to provide
catastrophic protection 6) Establish " Health Banks" to encourage
workers to obtain inexpensive catastrophic coverage and save for
their out-of-pocket health care costs 7) Encourage states to
establish risk pools to provide protection for uninsurable
Americans 8) Amend the law to permit corpor ations to make
tax-deductible contributions to fund retirement health plans for
their employees 9) Create private Health Care'Savings Accounts,
which workers could use instead of a portion of Medicare.

This package of reforms would not expand Medicare or t he
federal role. It therefore would not run the risk of opening the
Medicare door for future runaway expenditures and deficits.
Medicare has already shown itself susceptible to the tendency of
politicians to try to win applause by keeping premiums artific i
ally low while permitting outlays to rise. The Bowen plan proposes
what it claims is an Ilactuarially soundll addition to Part B of
Medicare to cover the full cost of catastrophic protection record
of falling woefully short of covering outlays. It is supp o sed to
cover 50 percent of physicians' costs reimbursable under Medicare
for example, but only pays for half of that. There can be little
doubt that premiums.to cover catastrophic costs soon also would
fail to keep up with outlays But the Part B premium a lready has a
Government certainly has a role in dealing with catastrophic health
care costs. But its role should be to provide a framework that will
stimulate efficient and appropriate private sector solutions.

Utilizing the private sector will foster competition and
innovation while ensuring that the finances of health care will
remain sound.

Turning to the government to raise and spend the money to pay
for catastrophic care invites politicians to engage in a bidding
contest to promise ever more generous benefits, leaving the next
generation to pick up the tab 3THE NATURE OF THE PROBLEM Medicare
Part A (Hospital Insurance or HI) now pays for'up to 90 days of
inpatient hospital care for each spell of illness, with 60
additional Illifetime- reserve days" wh ich an elderly American can
use at any time. This coverage is subject to a deductible of $520
per hospital stay, plus co-insurance fees of 130 per day for the
61st to 90th days of hospital#stay, and-$260.for each lifetime
reserve day.

Medicare Part B (Supplementary Medical Insurance or SMI) pays
for physician or other health related services, subject to an
annual deductible of 75 and a co-insurance fee of 20 percent of
approved charges.

Part A, or HI, is financed by a portion of the payroll tax on
working Americans, while a portion of Part B or SMI is paid f,or by
a monthly premium of $17.90 charged to each elderly beneficiary,
which pays for about 25 percent of program costs; the remainder is
'financed by general revenues.: The Medicare deductibles, co-in s
urance fees and premiums (except the $75 Part B deductible) are
indexed to current health costs Most elderly Americans have
additional protection. Over 70 percent have private supplemental
health coverage. Under law, this private protection must reimburse
the elderly for the Part A .and Part B co-insurance fees, and 365
days of hospital care beyond Medicare's coverage. Though private
policies must provide this minimum, most give additional coverage,
such as for unlimited hospital stays and the Part A deduc tible of
$5

20. The coverage is provided to the elderly through many
insurance companies and organizations for the retired including
Blue Cross/Blue Shield and about 200 other companies, the American
Association of Retired Persons (AARP) and the National C ouncil of
Senior Citizens (NCSC). In addition, group coverage is provided by
Health Maintenance Organizations (HMOs) and by many employers as
part of pension benefits. Moreover, over half of those elderly
without private supplemental health coverage are c overed by
Medicaid, which provides health care benefits to low-income
Americans.

Thus between Medicare, Medicaid, and the private insurance, the
elderly basically are covered for catastrophic expenses for acute
care provided by doctors and hospitals for sp ecific illnesses. The
expenses for such care can still be a big burden, of course, but it
is very rare for an elderly American today to have substantial
l'ife savings wiped out by hospital expenses. Very few elderly
Americans are in hospitals long enough to exhaust even their
Medicare coverage.

Those with savings generally have the resources to buy privatme
insurance providing further protection, and those without such
resources ultimately are backed up by Medicaid. To be sure, it
would be desirable to ens ure that no elderly person falls through
the gaps in coverage for catastrophic hospital costs policymakers,
however,-that this part of the problem is small and can It must be
recognized by 4be remedied by changes in current law extension of
the federal go vernment.

It does not require a massive The main problem for the elderly,
in,fact, is not catastrophic acute care expense's, but expenses for
long-term care in nursing homes. Neithe r Medicare nor the private
insurance generally covers such long-term care expenses. Many
private insurers are beginning to of fer such coverage but very
?few ss"of. the elderly' have' elected to obtain it. Nursing home
expenses are very high, usually betw e en $1,500 and $3,000 per
month, and can soon deplete life savings of most of the elderly,
leaving the burden on children or other relatives, or on Medicaid
That can be a mistake It would be enormously expensive for the
government simply to pick up all lon g -term care expenses. That
would increase federal spending by probably close to $20 billion
per year to start sensible approach.would be to spur the growth of
long-term care insurance, so that the elderly need not face the
risk of having their savings exha u sted by a debilitating sickness
near the end of their lives working lives to accumulate savings
that would be available to purchase long-term care insurance in
retirement or to pay into insurance plans that take effect upon
retirement I A more It should a l so be made easier for Americans
during their The third element of the catastrophic health care
problem comprises working-age Americans lacking adequate insurance.
About 90 percent of non-elderly Americans have health insurance
coverage through the private sector or Medicaid have catastrophic
coverage for acute care expenses in their insurance plans their
families encounter serious illnesses The great majority of these do
Those who do mot can face enormous medical bills, if they or WHY
EXPANDING.MEDICARE IS NOT A CURE Much attention has focused
recently on a proposal within the report on catastrophic medical
expenses, authorized by Health and Human Service? Secretary Otis
Bowen and presented to President Reagan late in 19

86. Bowen explained his ideas on Cap itol Hill last month. Bowen
proposes to expand Medicare to cover all current deductible and
co-insurance fees, except the first $2,000 in such expenses each
year. Bowen also would allow unlimited days of hospital care. This
extra coverage, says Bowen, cou l d be financed by increasing the
Medicare Part B premium by $60 per year 1. U.S. Department of
Health. and Human Services, CatastroDhic Illness ExDenses. ReDort
to the President, Washington, D.C November 19, 1986 5Bowen's
proposal is seriously flawed. It n o t only would not solve the
main financial problems facing the elderly, but almost surely would
increase the federal role and open the'sluices for a sea of red ink
in the Medicare account. As bad, it would transfer to the
government program the private ins urance coverage which the
elderly already have.

Many supporters of -the*: Bowen. plan do note correctzy that the
private policies cost substantially more than the 60 per year
change estimated by Bowen. But these private policies are required
by law to cove r most of the first $2,000 in expenses, which
Bowen's plan does not. Many plans, in fact, cover virtually all
these costs. Since there is a relatively high probability that a
retiree will incur some or all of such up-front costs each year,
these costs are quite expensive to cover. By contrast, catastrophic
coverage is not expensive, since insurers rarely need to pay out on
such claims is first-dollar insurance that pushes up costs.

As every motorist knows, insurance policies with no deductible
are far more expensive than those without first-dollar coverage.
Changing the legal requirements by allowing private insurers to
offer policies with higher deductib1e.s but catastrophic coverage
would bring down the cost considerably It The Bowen proposal would
offer unlimited coverage while 'the private policies are often
subject to caps of 365 days of hospital care and $5,000 of expenses
on the Medicare Part B 20 percent co-insurance fee. But as a
practical matter, very few of the elderly exceed the limits of such
p r ivate policies. To exceed the hospitalization coverage provided
by Medicare plus private policies for example, would require
hospitalization of 516 days for a single spell of illness.
Moreover, the law known as the Baucus Amendment which sets the
minimum r equirements for private Medicare supplemental policies,
could be changed to require unlimited coverage for the private
policies. Since virtually no one ever exceeds the current limits,
health insurers say they would support such a change ,and would not
in crease their premiums as a result. In fact, many private
policies already offer unlimited coverage for the Part B 20 percent
co-insurance fee.

The Bowen proposal thus would provide little or no additional
protection for all but a handful of Americans-and these could be
helped with alternative approaches.

All Bowen would accomplish would be to replace private coverage
with a government program and put the taxpayer at risk by inviting
Congress to play politics with future premiums and outlays 6AN
ALTERNATIVE TO MEDICARE EXPANSION Congress could deal with the
problem of high hospita1:costs for the elderly without any
expansion of Medicare, without revenue losses to the Treasury and
without any change in the tax reform enacted last year. Congress
could do this by Medicrap1 D olicies to reuuire catastrophic
coveraae state regulations set minimum standards for the private
policies. sold to the elderly to supplement Medicare. These
standards could be modified to require such policies to cover
unlimited days of hos p ital care after Medicare runs out and
unlimited expenses for the Medicare Part B 20 percent..co-insurance
fee. Since very few of the elderly ever exceed the current policy
limits, there would be little, if any increase in premiums. Yet it
would enhance co nfidence that these private policies provide
complete catastrophic acute care protection.

If the Baucus standards were modified further to allow insurers
to offer catastrophic policies with a deductible, say the same
2,000 per year envisioned in Bowen's Me dicare proposal, these
policies would cost far less than currently available policiesi
enabling more of the elderly to afford private insurance
protection. In fact, Robert Shapland, chief actuary for Mutual of
Omaha, one of the nation's largest insurance f irms, told the
Senate Special Committee on, Aging last month that his company
could provide exactly the same coverage envisioned by the Bowen
Medicare proposal for exactly the same 60 per year premium. Private
Medigap policies currently are costly because they must cover
almost all of a patient's out of pocket expenses.

This proposed change, of course, would.not prevent the elderly
from purchasing first-dollar coverage. The law simply would not
force them to do so in order to obtain catastrophic protection I .I
r I r I .s,,l.v I o Chanaina the minimum standards for Medicare
supplemental The Baucus Amendment, passed by Congress in 1980, and
companion o Providina vouchers for Medicare supplemental
policies.

Vouchers could be given to those elderly not on Med icaid to
help them pay the premiums of private Medicare supplemental
policies with catastrophic coverage with 60 per year toward such
premiums co-insurance fees could be raised to provide the funds for
the vouchers. Private insurance would be available, a s it is
tod'ay, to cover the deductible and co-insurance fees The voucher
could provide,each elderly retiree Medicare deductible .and 2. For
further discussion, see Private Sector Task Force on Catastrophic
and Long-Term Health Care, CatastroPhic and Lonp- T erm Health
Care-(Washington, D.C National Chamber Foundation, 1986 p. 20 7The
voucher program could be fashioned after the federal employee
health benefit system, where each employee receives a list of
competing private health plans eligible for employee health
benefits.

The employee chooses-the plan he or she feels is most attractive
and the cost is offset by the benefit package. Similarly, Medicare
could provide the elderly with details of eligible plans and allow
individuals to use their vouchers to hel p pay the cost of
whichever plan they preferred; a o Widenina the use of Medicare
vouchers Under the Medicare amendments passed in 1982, Medicare
beneficiaries have the option of choosing prepaid Health
Maintenance Organizations HMO) to provide Medicare c o verage. The
HMO chosen receives from the federal government each year 95
percent of the amount paid out annually for the typical Medicare
beneficiary. In accordance with federal requirements and to attract
elderly customers virtually all HMOs now offer ca tastrophic acute
care coverage without extra charge to each retiree who signs up
with the HMO.

This could be expanded into a full-fledged Medicare voucher
system with retirees free to choose to have their Medicare coverage
provided by any qualified insurer , including,HMOs, former
employers as part of pension coverage, and regular insurance
companies. Each insurer, however, would be required to provide
acute care catastrophic coverage without charge toleach retiree
choosing that insurer to provide Medicare coverage. This would help
the elderly to obtain catastrophic coverage under the umbrella of
Medicare with no extra premium, while decreasing total Medicare
costs.

DEALING WITH LONG-TERM CARE COSTS The greatest financial threat
facing the elderly is not the cost of hospital care but l.ong-term
nursing home care. This is not.easily addressed;,neither the Bowen
proposal nor rival plans offered by lawmakers would help today's
elderly. The best approach to the issue would be to tackle its
cause--inadequate fina ncial preparation for retirement by working
Americans. To do this, Congress could o Promote lona-term care
insurance.

The private sector is beginning to offer insurance to cover
long-term care. Federal studies and technical assistance could spur
the develo pment of such insurance education. campaigns among the
elderly concerning the need for such Washington also could conduct
3. Ibid., pp. 16-18 acoverage. Surveys show that most of the
elderly erroneously believe Medicare provides such"c0verage.
Washington also should consult more closely with the private
insurers to remove unnecessary government-imposed barriers to the
development of such insurance.

PROTECTION FOR WORKING'.'AMERICANS The issue of inadequate
insurance protection for working Americans centers on two problems.
First, though most workers and their families have health plans,
the Health Insurance Association of America estimates that about 5
percent of these plans do not provide catastrophic coverage. And
second, just o ver 10 percerrt of working Americans do not have
health insurance, due to uninsurable chronic health problems,
inadequate income, or other reasons. These problems could be
addressed by o Enactina minimum standards for tax-deductible
emlover coveraae.

Healt h insurance for those below 65 normally is obtained
through group coverage provided by employers, who receive a tax
deduction for the premiums. The availability of the tax deduction
could be limited to insurance plans that include a minimum degree
of cove r age against catastrophic illnesses. This would result in
little or no extra cost to employers because the slight probability
of any individual worker incurring catastrophic expenses makes
catastrophic coverage inexpensive. A small increase in front-end de
ductible or co-insurance fees, moreover, would provide sufficient
savings to the employer to offset whatever the cost of the
catastrophic coverage would be policy option would extend
catastrophic protection for those under 65.

This I o Establishina "Health Banks" to encouraae workers to
obtain inexpensive catastroDhic coverage and save for their
out-of-Docket health costs.

The existing tax deduction for employer-provided insurance could
be modified so that workers individually or their employers could
make tax-deductible contributions to a Health Bank instead of
purchasing health insurance directly. Health Bank funds would be
used to buy catastrophic-only health policies for retirement, with.
high annual deductibles of $1,000 or more, and to pay for out-of -
pocket health expenses, such as the deductible. Any funds remaining
after 65 could be used for retirement health insurance or medical
expenses, including long-term care uninsured workers to obtain
coverage, and help to restore incentives to counter rising health
costs This option would provide a new vehicle to help 9- :o
Encouraaina states to create uninsurable risk pools.

Wany.states, including Maryland, Iowa, Florida, and Wisconsin
have established uninsurable risk pools under which all insurers in
the s tate contribute to a pool that offers insurance to Americans
who are uninsurable due to chronic medical conditions. The premiums
normally are set at between-.l50 to-200 percent. of the..usua2
rates, but this still does not cover the full cost of the insur
ance. The remainder must be met out of insurer contributions to the
pool by insurance companies operating in the state. The federal
government could encourage all states to set up such pools in a
number of ways.

The Employee Retirement Insurance Act (ERISA which regulates
private employer pension benefits, currently prevents states from
requiring large companies which self-insure from contributing to
such pools.

Pool insurance should have a reasonably high deductible,
howeverl to minimize the subsidies whi le still providing essential
coverage LOOKING AHEAD These proposals constitute a package of
steps that would provide an immediate remedy to most of the
catastrophic cost problems associated with acute hospital and
physician care needs, and begin to deal w i th.the issue of
long-term care costs. The package would do this without basic
changes in the tax law or revenue losses to the Treasury. Beyond
this, Congress should take the opportunity offered by the debate
over catastrophic health costs to begin conside ring actions that
could involve revenue losses and could change Medicare but would
provide a more complete answer to the problem of catastrophic
health care costs.

Action is also needed to address the Medicare financing
crisis.

According to the latest governmept reports, Medicare will likely
run short of funds by the mid-1990s. The long-term financing gap
for Medicare is now much greater than the long-term gap faged by
Social Security before the crisis bailout amendments of 19

83. Paying all 4. Ibid pp. 2 7-28 5. 1986 Annual Rebort of the
Board of Trustees of the Federal HosDital Insurance Trust Fund
(Washington D.C U.S. Government Printing Office, March 31, 1986).
Under the most widely cited, intermediate, Alteinative IIB
assumptions in the report, the Ho spital Insurance program runs
short of funds to pay promised benefits by 19

96. Under the supposedly pesimistic Alternative 111 assumptions,
the program runs short of funds of 1993 6. Ibid I 10 the Medicare
benefits promised to today's young workers likely wilb require
raising Medicare:payroll taxes 250 percent to 500 percent.

This problem needs to be addressed now so that rational reforms
will havejsufficient time to work. If action is delayed until the
last minute, then the only options will be sharp payroll tax
increases or draconian benefit cuts. o Amendina DEFRA.

In the Deficit Reduction Act of 1984 (DEFRA), companies were
stopped from taking deductions for contributions made to a fund
during and employee's working years to pay for retirement health c
overage As a result, DEFRA has discouraged firms from providing
such insurance reasonable limit for contributions to prefund
catastrophic acute care coverage and long-term care coverage for
future retired employees.

This woulf increase such coverage significantly among future
retirees Employers should be allowed a deduction up to some o
Creatina Health Care Savinas Accounts.

The step that would have the most dramatic effect was contained
in bipartisan proposal introd uced in the House of Representatives
last year by Representative French Slaughter, a Virginia
Republican. This proposal would permit workers and their employers
to contribute to private Health Care Savings Accounts in return for
income tax credits. The wo r ker would use the funds in his account
to purchase private health insurance in retirement or to pay
medical expenses directly private coverage, his Medicare coverage
would be reduced throughout his career, he would receive
catastrophic acute care coverage under Medicare for medical
expenses above the payments from his Health Care Savings Account be
available for long-term care expenses. If a retiree spent less than
a specified proportion of funds,in his account each year. on
medical expenses or insurance, h e could withdraw the difference at
the end of the year without restriction To the extent that the
worker exercised this option for If a worker exercised the account
option to the minimum level The funds in the account would also 7.
1986 Annual ReDort of t h e Board of Trustees of the Federal
Old-Age and Survivors Insurance and Disabilitv Insurance Trust
Funds (Washington, D.C U.S. Government Printing Office, March 31,
1986 Appendix E; Harry C. Ballantyne, Chief Actuary, Social
Security Administration Long-Ra n ge Estimates of Social Security
Trust Fund Operations in Dollars," Actuarial Note 127, Social
Security Administration, April 1986 8. CatastroDhic and Long-Term
Health Care OD. cit pp. 10-1 1, 22 11 The Slaughter plan would
address catastrophic and long-te rm care costs for the elderly. It
would give the private sector responsibility for the great majority
of health expenses for the elderly, reserving the back-up
catastrophic role for the government.

Most important, the long-term Medicare financing crisis could be
eliminated through this option, without cutting benefits for the
elderly or increasing payroll taxes for workers. Since workers
would receive an income tax credit for their co ntributions,
Medicare payroll tax revenues would not be cut. But Medicare
spending would be reduced by the increased deductibles, as workErs
relied more on their private sector accounts and less on Medicare
CONCLUSION There is no disagreement about the ne e d to deal with
the problem of catastrophic health care costs. Huge hospital and
physician bills can devastate a family, and the specter of medical
or long-term care costs haunts many elderly Americans. But agreeing
that the problem exists does not mean th a t lawmakers should rush
to accept the idea of a significant expansion of the federal
government. Expanding Medicare to address the catastrophic cost
problems of the elderly inevitably would be the first step on a
very slippery and expensive slope It would be difficult to draw the
line on benefits. Lawmakers would be under continuous pressure to
increase coverage, but likely they would flinch from raising
premiums to pay for these benefits. And younger Americans,
believing that federal programs would take c are of their
ret.irement health.needs; would have even less incentive than they
do now to make adequate provision for their retirement. The result
would a federal program which grows steadily larger while sliding
deeper into the red.

The alternative is for the federal government to create a
framework in which the private sector is encouraged to provide
adequate insurance protection on a financially sound basis, and
younger Americans are given the incentive to set aside funds to pay
9. Ibid pp. 12-16, 23 10 For futher discussion, see ibid 12 for
their retirement needs. such a framework Congress should move
swiftly to enact c Prepared for The Heritage Foundation by Peter J.
Ferrara a Washington attorney, formerly a member of the White House
Office of c I. I I a r, pol'~cy DeVelopmneant'.'s .1.1 and Stuart
Butler, Ph.D.